Monday, April 19, 2010

State Bailouts are in Full Swing.

While European authorities and taxpayers wring their hands and wrangle over how to handle the bailout of EU member Greece, the US is quietly forging ahead with bailouts of profligate state and local governments, and the effort is rapidly gaining steam. It started with "Build America Bonds", an Obama plan that subsidizes the interest cost of municipal bonds, effectively lowering the cost of state and local borrowing at federal taxpayer (eventually dollar saver) expense. These federal handouts have become quite popular and are now the fastest growing segment of the muni bond market, with over $95 billion issued in just a year. Wall Street likes them too due to their ability to raise fat fees by handling issuance, often charging higher fees than traditional muni bond deals according to the Wall Street Journal.

Mainstream media coverage of the Build America subsidy has been predictably low key and mostly favorable, choosing to focus on "job creation" rather than the pernicious impact of piling more debt on an insolvent debtor nation. Not surprisingly, Obama is now considering making the Build America program a permanent part of America's welfare state and even expanding the eligibility of the bonds to a broader range of uses. Local governments are enthusiastic about that prospect, and what's not to like for local politicians. Federal subsidy of municipal debt enables irresponsible spending, while non-constituents pick up part of the tab. That's a free lunch, until the whole system breaks down.

But, as we wind our way down the road to serfdom it was inevitable that a partial subsidy of interest would prove inadequate for truly favored constituencies. Thus, local school districts have discovered an even fatter plum, Qualified School Construction Bonds. As Bloomberg reports, these instruments allow the federal government to pick up as much as 100% of the interest cost of the debt.

"Qualified school bonds “are just about the lowest cost of financing on earth,” said Jean Buckley, president of Tamalpais Advisors Inc. in Sausalito, California, the financial adviser for the Los Angeles offering." That statement is, of course, completely incorrect. The cost is not changed, only the individuals bearing the burden of that cost. Thus, the city of LA (and the state of California) gets the free use of your money for their benefit, without any accountability to you. That is the definition of taxation without representation.

"Underwriters led by Goldman Sachs Group Inc. will market the school bonds. A group led by Citigroup Inc. will market the tax-exempt debt." This pattern that has become disgustingly familiar to those of us drawing zilch on our dollar savings; free money raining from the heavens on those appropriately situated in our entitlement society, being distributed (with an appropriate cut off the top) by others who are similarly situated. Will anyone be surprised when this program is also expanded to uses beyond school districts?

Once again, America outdoes Europe's socialists in a grand way. We don't require austerity from our over-indebted states; we don't even have a serious debate about the wisdom of enabling their promiscuous spending. Instead, we give them a federal handout with no strings attached and every incentive to over spend at an even greater level since the cost is being dispersed to people who don't vote in local elections. It is in the interest of every local electorate and politician to procure and spend as much US subsidized debt as possible. Underlying the whole process is the near certainty that many of these municipalities will eventually default on the debt anyway (just as home owners receiving mortgage modifications continue to default), leaving federal taxpayers to step in and bail them out. Eventually, all of these costs will be born by savers of US dollars, as neither local, state, or federal governments have any capacity to repay this debt.

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